In China 1300 Hedge Funds “Did Not Fight The Central Bank” And Are Now Liquidating

When it comes to manipulating stock markets, there is the Western way in which central banks either directly, or – like in the US – indirectly, thanks to a very close relationship between the NY Fed and the world’s most levered hedge fund Citadel, documented here since 2010 – in which central bank trading desks end up buying index futures or merely use massively-sized orders to spoof the market higher (and very rarely lower), and then there is the Chinese way in which the local plunge protection team named the “National Team”, which has already spent around $300 billion to (ineffectively) halt the bursting of the Chinese stock bubble – buys individual stocks.

The problem with both strategies is that they both ultimately fail to keep asset prices artificially propped up, but while the western approach at least provides some temporary relief which in the case of the S&P has now lasted almost 7 years, the Chinese approach is an abysmal failure, especially since unlike the US, China’s PPT – whether it wants to or not – has to report its single-name stock purchases.

Recall on July 22 we reported that China’s Securities Finance Corp, the central bank-backed market bailout institution, had quietly become among top 10 shareholders of many listed-firms. “Among its various other investments, at least eight firms have confirmed that the CSF is now a top-10 shareholder, which include property developer Dulexe Family, Hualan Biological Engineering, resource purifying developer SJ Environment Protection, Yunnan Tin Company Group, Fujian Cosunter Pharmaceutical Co, Hunan Er-Kang Pharmaceutical Co, digital map provider NavInfo Co, and retailer Friendship & Apollo.”

This direct intervention in individual names would continue for over a month, and it had spectacular results… for a very brief period of time.

As Bloomberg reports, “Eastern Gold Jade rallied by the 10 percent daily limit on Aug. 17, the first trading day after disclosing China Securities Finance had accumulated a 4.2 percent stake as its third-biggest shareholder.”

When the filings came in – showing China Securities Finance Corp. had taken major stakes in companies as part of its market-rescue effort – traders jumped to buy what they dubbed on social media as “the King’s favorite concubines.” It was a drunken orgy of backrunning the central bank. No risk right? Wrong.

Because that’s when the hangover started, and gains quickly evaporated with the stock of Eastern Gold Jade tumbling 49% in the month since the announcement, compared with a 24 percent retreat for the Shanghai Composite. Even after the losses, the Shenzhen-based company – which reported a 37 percent drop in net income last year – trades at 4.7 times price-to book.

And just like 13F clones end up getting burned more often than not, so too unfortunately for the Chinese copycats, an endorsement from the equity market’s savior has done nothing to ensure outsized returns. In fact, as Bloomberg adds, it was just the opposite – the stock picks have trailed the broader market. The 46 companies that reported the agency as a top 10 shareholder in the past two months lost an average 29 percent since the announcement, versus a 21 percent drop for the Shanghai Composite Index.

One suggestion proposed by BBG is that the underperformance is a sign that the pace of China Securities Finance purchases is slowing as authorities become less concerned about an equity-market freefall. “While the agency will remain in the market for years to come, it won’t normally step in unless there’s unusual volatility and systemic risks, the China Securities Regulatory Commission said on Aug. 14.”

However, we fail to see where the systemic risk was overnight when the Shanghai Composite soared by nearly 6% at one point before closing up 4.9% its biggest intraday surge in years, after two days of vicious declines in Chinese stocks. Far more likely, the fast buyers realized upside was capped and with memories of the recent collapse still fresh in everyone mind, fast buyers turned even faster sellers especially since the government backstop was no longer guaranteed.

But if the pain was focused only on retail sellers, that would be understandable – after all “mom and pop” (or grandma and farmer in China’s case) are best known for buying high (and on margin), and selling low. However, in a separate Bloomberg piece we learn that a far bigger loser than retail were China’s supposed “smartest money” investors, the countless hedge funds formed in the past year to chase the artificial market surge.

The newfangled industry, short on expertise and ways to protect itself from market declines, has seen almost 1,300 funds liquidate amid China’s $5 trillion stocks selloff, and a similar number may be at risk, according to Howbuy Investment Management Co. Now, a government crackdown on short selling and other hedging strategies have made prospering in a bear market difficult.

In the most devastating blow to domestic hedge funds, China has imposed new restrictions on trading in stock-index futures, a key investment strategy to dampen volatility and avoid big losses.

“It spells the end, at least temporarily, for China domestic hedge funds,” Hao Hong, chief China strategist at BOCOM International Co. in Hong Kong, said in an interview.

There is a key difference between US “hedge funds” and those in China: most of them are long-only, meaning they bet solely on rising markets. “Even before government restrictions on practices such as short-selling, many limited hedging so they maximize benefits from a market that had advanced almost 50 percent in the two years through 2014 and rallied another 60 percent through mid-June. William Ma, Hong Kong-based chief investment officer of Gottex Penjing Asset Management (HK Ltd.), said that most of the liquidated funds were launched in April and May when valuations were high, making them the “first and largest wave” of closures. While funds set up late last year or early in 2015 still face liquidation risk if the market drops further, they are fewer in number and have high cash positions, said Ma, whose firm invests in hedge funds.”

The bottom line: “more than 50 percent of long-only new products launched this year have liquidated, according to estimates from Guo Tao, a board member of the Hedge Fund Talents Association, affiliated with the Zhejiang provincial government, whose members collectively manage about 300 billion yuan.”

And to think, if only these hedge funds had not blindly followed in the footsteps of the PBOC, and copycatted its strategies, they would still be alive.

The irony is even greater: if only these hedge funds had fought the Chinese version of the Fed, and shorted the stocks the PBOC had been buying, while shorting the overall market, they would be massively outperforming now. Perhaps there is a lesson in there, somewhere as the world awaits the Fed’s most “important decision ever”…

Then again, not everyone blew up: “The real hedge funds,” which use risk-management tools including stock index futures, recorded mostly positive returns in the June to August period amid the market turmoil, Guo said.

Ah yes, speaking of indices, going back to the first topic, the deplorable performance of the Chinese PPT, Bloomberg notes “in terms of what it bought, the government fund has done a terrible job,” said Francis Lun, chief executive officer at Geo Securities Ltd. in Hong Kong. “They should have just bought index stocks.””

Indeed they should: after all that’s what the Fed does. Actually, what China should have done is even simpler – listen to our advice:

Hey @NYFed_News can you please send Kevin Henry to China to teach them how to manipulate markets? This is embarrassing